How to Reverse a Roth Conversion and Adjust Your Tax Filing

Reversing a Roth conversion, known as recharacterization, can be a strategic financial decision for those who find the tax implications of their initial choice unfavorable. This process allows individuals to undo a previous conversion from a traditional IRA to a Roth IRA, potentially leading to significant tax savings.

Understanding this process is essential for managing retirement funds and optimizing tax strategies. Here’s what you need to know.

Eligibility Requirements

The Tax Cuts and Jobs Act of 2017 eliminated the option to recharacterize Roth conversions after 2017. If you converted funds in 2017 or earlier, you might have been eligible to recharacterize under the old rules. For conversions made in 2018 and beyond, recharacterization is no longer available. This underscores the importance of staying informed about tax legislation.

While Roth conversion recharacterizations are no longer allowed, other types of recharacterizations are still permissible. Contributions made to a Roth IRA can be recharacterized as contributions to a traditional IRA, and vice versa, provided the recharacterization is completed by the tax filing deadline, including extensions. This can be helpful if changes in your income affect your eligibility for Roth contributions. For 2024, the income limits for Roth IRA contributions are $153,000 for single filers and $228,000 for married couples filing jointly.

Steps to Recharacterize

Recharacterizing a Roth conversion involves following key steps to ensure compliance with IRS rules and optimize your financial position.

Confirm the Conversion Details

Start by verifying the details of your original conversion, including the date, amount, and accounts involved. Accurate records are critical for the process and for amending your tax filings. The recharacterization must be completed by the tax filing deadline for the year of the conversion, including extensions. For instance, if you converted funds in 2023, you must complete the recharacterization by April 15, 2024, or October 15, 2024, if you file for an extension.

Notify the Custodian

Inform the financial institution managing your IRA accounts by submitting a formal request. Specify the amount to recharacterize and the accounts involved. Most custodians require a recharacterization form detailing these specifics. The custodian will transfer the recharacterized amount from the Roth IRA back to the traditional IRA, adjusting for any gains or losses during the time the funds were in the Roth IRA.

Document the Recharacterized Amount

Once the custodian processes the recharacterization, update your financial records to reflect the changes and retain all documentation for tax purposes. You must report the recharacterization on your tax return for the year the original conversion was made, typically using IRS Form 8606. Proper documentation ensures compliance and accurate calculation of any tax implications.

Adjusting Tax Filings

Recharacterization nullifies the initial Roth conversion, requiring you to amend your tax return to remove any income previously reported from the conversion. For tax year 2024, this may involve revising IRS Form 1040.

Consider how the recharacterization affects your taxable income and eligibility for deductions or credits. A lower adjusted gross income (AGI) could improve your ability to claim deductions, such as medical expenses, which are deductible only when they exceed a certain percentage of AGI. Similarly, it could impact eligibility for benefits like the Child Tax Credit or the Earned Income Tax Credit. A thorough review of your tax situation post-recharacterization is essential to ensure accuracy and maximize potential benefits.